Private banks and other firms catering to high net worth clients have snapped up a large chunk of new renminbi-denominated debt recently, attracted by valuations and long-term potential as an asset class, Nikko Asset Management says.

Private banks and other firms catering to high net worth
clients have snapped up a large chunk of new renminbi-denominated debt recently,
attracted by valuations and long-term potential as an asset class, Nikko Asset
Management says.

But while the RMB-based debt market has come a long way in a
short period of time as a market, investors still demand a premium when
compared to equivalent US
debt maturities, which may seem perplexing given the US’s immense fiscal woes, the firm
said in a presentation to journalists yesterday.

Part of the reason for a higher risk premium, at around 120
basis points in mid-2012 on A-rated debt securities (5-year maturities) at the end of June this year (source: Nikko AM presentation graph) is investor
concern that the market is still relatively undeveloped, illiquid and
under-researched, although this is changing, Nikko Asset Management said.

Large institutional investors such as pension and insurance
funds would take time to push more into RMB-based debt, while family offices,
private banks and similar bodies could afford to be bolder and less restricted
by rules, argued Charlie Metcalfe, president, Nikko AM.

“Family offices and other high net worth private client
managers are able to be a bit more creative in terms of the asset classes they
look at,” he said. “We’re definitely getting some interest.”

Speaking at the same event, Leong Wai Hoong, portfolio
manager and member of the firm’s fixed income team, said that private banks are
now buying up to around 35 per cent of new RMB debt issuance.

New funds

Managers at Nikko AM have been travelling around the world
to promote what they see as the merits of RMB debt at a time when investors are
speculating on the likelihood – and timing – of when China fully floats the RMB
against currencies such as the dollar and euro. At present, the currency is
allowed to move within narrow bands. The forex policy of China’s
authorities – keeping the currency from appreciating rapidly as it might do in
a full free market - has at times been a bone of contention. In the recent US presidential elections, Republican candidate Mitt
Romney had vowed to “crack down” on China for its alleged “unfair”
trading practices.

The asset management house, with total client assets of
around $154 billion, launched the Luxembourg-registered Nikko AM Asia Credit
Fund at the start of November. The fund seeks returns from capital appreciation
and yield income; the firm is also due at some point to roll out the Nikko AM RMB Bond Fund, also domiciled in Luxembourg.

Progress

Performance of Asian debt has been relatively robust. The JP
Morgan Asia Credit IG index has delivered total returns (capital growth and
yield income) of 6.56 per cent since 2005, with 7.75 per cent volatility; the
Citi World Government Bond Index, by contrast, delivered returns of 6.03 per
cent and 7.18 per cent volatility. The MSCI World Index of developed nations’
equities has been battered by the 2008 crisis, achieving returns of 3.38 per
cent since 2005 (source: Nikko
AM). This sort of performance, and valuation benefit, is encouraging more
issuance.

The Asian bond market, in terms of outstanding issues, has risen from
$460 billion in December 1997 – the year of the Asia
market crisis – to around $6.8 trillion now, although it is still small
compared to the global total of around $100 trillion. But recent developments,
such as actions by the Chinese authorities to boost trading in RMB debt and
related instruments, should promote the asset class, Nikko AM said. For example, in the first half
of this year, the People’s Bank of China and Bank Indonesia
reached a deal enabling the latter bank to invest in China’s interbank market. China has also signed a memorandum of
understanding with Singapore
over cross-border collateral.

“Asia debt should now be
seen as a stand-alone asset class,” Koh Liang Choon, head of the company’s
fixed income team, told the same presentation.

There are challenges with the current RMB market, however.
For example, about 40 per cent of investable debt is not rated. Most bond
maturities are clustered around the one- to three-year maturity horizon, with
relatively few longer-dated debt securities available.

Of course, there is always a risk that Asian countries could
adopt bad fiscal habits. But for the moment at least, the numbers seem to stack
up well for holding RMB-denominated debt, assuming a certain risk-reward
appetite, so Nikko AM is likely to be not alone in singing the praises of these
markets.